Virginia economy is hostage to the federal government, economists say

Virginia's new governor may have won in part by defying President Trump, but he'd better find a way to work with the White House and the Republican-led Congress or the state's economy could go down the drain, according to a new report from economists at Old Dominion University.

So many threats are looming — the possibility of more automatic spending cuts from Congress, calls for a new round of military base closures, tax restructuring that increases the deficit and drives up interest rates — that Gov.-elect Ralph Northam (D) will have no choice but to seek common ground with Washington, ODU economist Robert M. McNab said.

"This may not be popular in the governor-elect's party, but ignoring or opposing the administration could be a costly course of action," McNab said.

ODU's annual "State of the Commonwealth Report," released Sunday, makes clear that Virginia's economy remains a web of contradicting statistics. The state's growth has trailed the rest of the nation for the past six years as it struggles to recover from the recession. The economy barely grew in 2016, but picked up steam in 2017 and should hit a 1.8 percent growth rate for the year, the report said.

But that will still lag behind the national growth rate, which has bumped up to about 3 percent in the most recent quarter.

The state's unemployment hit a post-recession low of 3.6 percent Friday, one of the lowest in the country. In September, the Virginia labor force hit 4.4 million — up about 85,000 from the same time a year ago, according to the ODU report. As of July, the state had "the largest labor force and the largest number of employed Virginians on record since data collection began in 1976," the report said.

Still, wages continue to be soft, and jobs are not being produced uniformly around the state.

The metropolitan areas of Northern Virginia, Richmond and Hampton Roads account for 73 percent of the state's jobs, but all three have seen slower job growth in 2017 than in 2016, the report said.

Manufacturing accounts for only about 6 percent of Virginia jobs and is unlikely to come back in the coal areas of the state's southwest or the old textile mill region on its southern border.

The report suggests that the state's new governor can help improve some of these situations by decreasing regulation for small business, fostering regional cooperation, improving the state's education system and investing in research and development. But only one thing amounts to a silver bullet.

"In the next year or two," the report said, "the only undisputed way to supercharge the Virginia economy is for the federal government to end budget sequestration."

Sequestration is the system of automatic budget cuts enacted by Congress in 2013 when it could not reach a budget deal.

Virginia's fortunes are more tied to the federal budget than those of perhaps any other state. Almost 30 percent of Virginia's gross domestic product — its total output of goods and services — is directly related to federal spending, the report said.

Home to both the Pentagon and the world's biggest naval base — in Norfolk — Virginia ranked at the top of all states in annual federal spending per capita in fiscal 2015, the most recent year for which statistics were available.

But ever since the financial crisis and the two-year recession that began in late 2007, those federal dollars have shrunk. From 2008 to 2016, total federal contracts in Virginia fell 7.8 percent, the report found. Contracts for defense work plunged more than 21 percent, and even the total number of military personnel in the state fell by more than a quarter from 2008 until June of this year.

The boom-and-bust cycles are so directly tied to Virginia's economy that "federal spending in the Commonwealth is akin to oil and natural gas for Alaska and North Dakota," the ODU researchers wrote.

The report expresses some optimism that Congress will raise spending caps for 2018 and that defense outlays will grow for the second half of next year. "Such increases would be welcome news and would spur increased economic growth, subject to the usual caveats on economic and political shocks," the report said.

But the tax bills before Congress could undermine that boost, McNab added. Big tax cuts that increase the deficit could cause both interest rates and inflation to rise, he said — making it less likely that defense spending will go up.

At the same time, tax provisions that would make higher education more expensive — such as removing the deduction for student loan interest — could hurt the state in a different way.

Virginia's public colleges and universities, considered among the best in the nation, are going way up in cost, which makes the state less attractive to businesses, McNab said. From 2002 until this year, tuition and fees at Virginia four-year public colleges and universities went up an average of 74 percent.

The state's median household income went up about 22 percent in that time — but adjusted for inflation, income actually declined nearly 9 percent.